The standard security for a Fixed Income investor is the bond - government, corporate, high yield or otherwise. Since bond interest rates are at all time lows, their income is low and their potential for price appreciation has disappeared. An alternative way to invest is through corporate loans made to companies that are rated below investment grade. These loans have a variable interest rate of LIBOR plus a spread. Bonds are generally fixed rate instruments. Their value will rise and fall according to the market interest rate.
Loans are less likely to default and are also first in line to recover losses if the company becomes bankrupt, being senior to bonds, preferred securities and equities. They recover 60%-70%. Bondholders recover 25%-40%. Why is that? Loans are secured by real assets and protective covenants. These covenants may give the investor the right to accelerate loan payments, update the loan terms if the borrower's credit changes and buy the loan at a discount to par.
They may be used to create collateralized loan obligations (CLOs). One hedge fund in Dallas, Carlson Capital I think, used this strategy six or seven years ago. Hearsay data from a banker that I shared an elevator with.
Loans may be a more efficient fixed income instrument in the current low interest environment. They are paying investors more than bonds for taking on less credit risk and are a hedge against a rise in interest rates.
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